Finding a Target at Nosebleed Levels

10/31/2013 6:30 am EST

Focus: TRADING

Three consecutive weeks of solid stock market gains has left many traders without any signposts to assess how far it can continue, but technician Greg Harmon of Dragonfly Capital offers a couple of ways to tell.

When stocks or indexes move to new all-time high levels technicians need to shift gears. No longer are there any potential resistance levels to the upside from previous price action. You can try to tell me that on an inflation-adjusted basis there are still higher highs, but it is just utter nonsense to think there is memory adjusted for inflation in a world where people cannot even balance their checking accounts.

So what are you left to do to be able to judge the upside? Trend traders would tell you that it does not matter. Just hop on and get out when your stop is hit. That is one way to play the market at all-time highs, but there is another way, that also allows you to measure the risk vs. reward ratio. At times like these, technicians shift to tools that give extension targets. There are two of these methods on the chart of the SPDR S&P 500 ETF (SPY) below, that give several potential upside targets. And it just so happens that they agree on one level, 185.50.

chart
Click to Enlarge

The first method is simple, a measured move. Looking at the two orange boxes shows that the first one measured a jump higher of 11.40 points. Applying that same move to the slight pullback on October 23 gives an upside target of 185.50.

The second comes from harmonics and extension the AB=CD diamond. Typical extensions come at 113%, 127%, 138.2%, 150%, 161.8% and 200%. I have labeled these levels and notice that it is the 200% extension that also targets 185.50. None of these levels are places where you would sell the SPY, but where from the harmonic flow, there is potential for a reversal. So this is a place to watch a bit closer or maybe even tighten a stop to.

By Greg Harmon of Dragonfly Capital

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